The U.S. economy is changing. Indeed, it already boasts far fewer brick-and-mortar stores and packaged goods than in days past.
And if we project this trend forward, we see the potential for companies whose entire rationale is the ownership of ideas. These companies would have a small staff and manufacture nothing, yet they’d boast profits that are well worth an investment.
This is important for income investors, because we need to focus on where the economy is going – not where it’s been.
Accordingly, this week’s opportunity is a company with trivial tangible assets beyond cash. In fact, it has just 10 employees… but it boasts an excellent dividend that’s fully covered by earnings.
PDL BioPharma (PDLI) was founded in 1986 to produce monoclonal antibodies… but in 2009, it changed its name and began managing a portfolio of patents and royalty assets.
With just 10 full-time employees (as of late 2013), PDLI neither manufactures nor markets. Instead, it uses the expertise of its management to profit from intellectual property (IP). And the company has been profitable, indeed. In both 2012 and 2013, it made over $200 million in net income – and in the first three quarters of 2014, it had already brought in $267 million.
Best of all, the company’s trailing four quarters P/E ratio is a minuscule 3.6x, and it pays a generous dividend of $0.15 per quarter that equates to an 8.2% yield. Based on trailing earnings, that dividend is covered 3.3 times over.
Of course, there’s a catch – as there always is when the numbers look that good.
You see, most of PDLI’s income is derived from a collection of “Queen” patents relating to humanized antibodies that expired at the end of 2014.
And even though PDLI won a lawsuit against GlaxoSmithKline (GSK) that will keep Queen patent income flowing until early 2016, PDLI needs to find replacement sources of income as soon as possible.
A Glimpse Into the Future
Luckily, the firm has a cash pile of about $280 million at the last balance sheet date, and it can use that cash to pursue new income opportunities. Plus, it’s already invested around $780 million in new revenue-producing assets, including deals with drug developers that effectively act as financing transactions.
For example, in 2013, PDLI invested $240 million for the right to receive royalty and milestone payments for sales of diabetes products licensed by DepoMed (DEPO). Under this agreement, PDLI will get all royalties until it has received twice the amount of money invested, after which it will split receipts 50-50 with DepoMed.
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Another recent debt financing agreement with Durata Therapeutics (DRTX) had an interest rate of 14% for a five-year term. And when Durata was acquired by Actavis (ACT) in November 2014, PDLI received full repayment, accrued interest, prepayment penalty, and change of control fees.
Most recently, PDLI invested $66 million to purchase 75% of the University of Michigan’s royalty interest in Cerdelga until the expiry of the licensed patents. The first payments under this deal are expected to arrive in the first quarter of 2015.
Ultimately, investors are relying on the skills of PDLI’s very lean management to find and structure deals that make sense. And though there’s little chance that future net income will equal the stellar levels of 2012 to 2014, I believe PDLI management will prove that they can find intellectual property deals that enhance shareholder value, allowing PDLI’s substantial dividend to continue.
Over the longer term, PDLI appears to have a viable business model. After all, large companies – in pharma or elsewhere – aren’t very good at innovating. Instead, this task is often carried out by smaller outfits with entrepreneurial management and little or no bureaucracy.
Of course, the smaller outfits need resources to get their innovations to market – and one way they can obtain these resources is by selling out to the big guys. But in the long run, this may doom their innovations (especially because management will have to deal with big company bureaucracy).
Alternately, they can license innovations to IP management companies like PDLI, which allows the innovators to remain small while giving PDLI returns from IP assets that far outstrip what’s available in other financing businesses.
I believe this model for virtual business should become more common in the future. And in the meantime, PDLI’s 8.2% yield and decent track record are worth looking at closely.